Financial Ratios and Financial Distress: Evidence from Indonesian Industrial Subsectors

Abstract: This study intends to examine how financial parameters, such as the current ratio, retained earnings to total assets, earnings before interest and tax to total assets, return on equity, debt to equity ratio, and net profit margin, affect financial distress. This study makes use of secondary data in the form of information taken from annual reports or financial statements of companies This study employs a quantitative approach method with multiple linear regression analysis approaches utilizing SPSS software. The population of this study consists of businesses in the industrial subsector that are listed on the Indonesia Stock Exchange (IDX) for the years 2018 through 2021. Purposive sampling was used in the sampling procedure, which led to the collection of 168 data from 42 companies. The study's findings show that the current ratio, retained earnings to total assets, earnings before interest and tax to total assets, return on equity, and debt to equity ratio are statistically significant in influencing financial distress. In the meantime, financial distress is unaffected by net profit margin.

Keyword: current ratio, debt to equity ratio, earnings before interest and tax to total assets, net profit margin, retained earnings to total assets, return on equity

I. Introduction

The financial performance of businesses will undoubtedly be impacted by an unpredictable economic environment in a nation. A bankruptcy could result from this money issue. A few financially troubled enterprises attempt to control their situation by taking out loans, combining their operations, or even going out of business. The bankruptcy, especially in a large company, will also have negative consequence for management, creditors, investors, and the government as well In Indonesia, debtors who have two or more creditors unable paying at least one debt can be declared as bankrupt by a court decision either at the request of five or more creditors or at their own request. The bankruptcy can be indicated by a financial distress, a condition that is characterized by a decrease in a financial condition (Platt, 2002)

The goal of this study is to develop a financial ratio-based model that may foretell a company's insolvency, particularly when it results from financial duress. Finding out how financial ratios affect financial distress is the goal of this study (Brahmana, 2004; Setiawan, et al., 2009). Financial distress is measured by Whitaker (1999) using a lower cash flow value for current long-term debt. By examining the financial reports, the degree of financial crisis can also be determined.

On the other hand, financial ratios are excellent tools for computing financial statements since they provide information about a company's past, present, and future conditions (Khaliq, et al., 2014). Altman(1986) conducted early research on the Z-score, which is a measure of financial ratios used to forecast insolvency. Financial ratios can be used to predict a company's future state, according to research by Brigham & Houston (2010). The use of financial parameters to forecast insolvency was then discussed by Almilia & Kristijasi (2003).